Taxation of Life Insurance

Charitable deduction

IRC permits a full gift tax deduction for gifts to qualified charities individual can donate a life insurance policy to a qualified charity without incurring any gift tax and will receive a charitable income tax deduction as well income tax deduction is based on the lesser of the policy's replacement cost or the owner's adjusted basis in the policy

Gift tax law

a lifetime gift to an individual incurs a federal gift tax generally at the same rate as the federal estate tax for 2016 the maximum amount of lifetime gifting is reunified with the estate tax at $5,450,000 taxable gifts are amounts that exceed the annual exclusion amount of $14,000 a person could gift more than $5,450,000 in his/her lifetime without incurring a gift tax by gifting in increments of $14,000 since annual exclusion amounts are not taxed

Adjusted gross estate

allowable deductions are subtracted from the gross estate, which results in the adjusted gross estate allowable deductions include funeral and admin expenses, debts of the decedent, certain taxes, and casualty or theft losses deductions include bequests to the surviving spouse and to qualified charities-- marital/charitable deduction deduction is also taken for state death taxes paid a decedent who is the owner/insured of a life insurance policy will have the death benefit proceeds included in his or her gross estate at death-- unless spouse or charity is the beneficiary

Dividends

an amount paid on participating insurance policies dividends received from a mutual life insurance company are not subject to federal income tax—IRS views these dividends as a return of part of the premium and not as earned income if dividends are paid to owners of stock, such dividends are a taxable return on their investment

Future interest

any interest in property that does not pass into the recipient's possession or enjoyment until some future date exclusion is not available for these types of gifts life insurance policies transferred into an irrevocable trust are considered a gift of future interest since the beneficiaries do not receive the proceeds until the insured dies-- why many ILITs contain "Crummey" provisions

Federal estate tax

arrived at by adding the taxable estate to adjusted taxable gifts, which are gifts made after 1976, to yield the tentative tax basis reason for this addition is that the estate tax law is part of a unified transfer tax law that applies to transfers made at death and even during life it is necessary to add the value of lifetime taxable transfers (gifts) back to the tax base to derive the appropriate marginal tax bracket appropriate tax rate is then applied to the tentative tax base to derive the tentative federal estate tax from this tentative tax is subtracted certain credits for gift and other taxes paid as well as the unified credit **federal estate tax return must be filed and any estate taxes paid within 9 months of the death of any US citizen or resident who leaves a gross estate of more than a specified exempted amount $5,450,000

Gross estate

composed of the value of the decedent's interest in all property outright ownership of property is not required for value to be included in the gross estate value for estate tax purposes is the FMV of the property at the date of death decedents who are owners of life insurance policies, or have any incidents of ownership in life insurance policies, will have the death benefit included in their gross estate at death person who is an owner of a policy but is not the insured, can transfer that policy any time prior to death, and the value will not be included in their gross estate at death-- 3 year policy transfer rule

Accelerated death benefits

early withdrawal of death benefits in cases where insured are terminally ill regulations provide that payments meeting a 3-part test will be identified as a qualified accelerated benefit, in which case the benefits may be received on the same tax-free basis applying to conventional benefits: 1) insured must be terminally ill 2) the reduction of the remaining face value of coverage is limited 3) the cash value of the remaining death benefit may not be reduced

Health insurance taxation

employers can deduct medical and health insurance premiums, and the premiums are deductible to employees subject to 10% of AGI limits

1035 exchange

existing life insurance policies and annuity contracts can be exchanged for new policies and contracts with different insurance companies as a tax-free exchange as a like-kind exchange if the current owner is named the new owner of the policy or annuity contract no gain/loss shall be recognized on the exchange of the following: contract of life insurance for another contract of life insurance or for an endowment or annuity contract contract of endowment insurance for another contract of endowment insurance which provides for regular payments at a date not later than the date payments would have begun under the contract exchanged OR for an annuity an annuity contract for an annuity contract

Estate tax treatment

federal estate tax is assessed on a person's right to transfer property at the time of his/her death calculated on the value of property, not a tax on the property itself

Policy on another person's life

if a person owns a policy on another person's life, only the replacement cost of the policy at the time of the owner's death is included in his or her estate

Gift of insurance contracts

if an insured irrevocably assigns all rights in an existing insurance contract for less than an adequate consideration, a gift of the contract is made and gift taxes may be due if the owner receives an adequate consideration for the transfer, it is a sale not a gift if the owner gifts an existing contract upon which premiums remain, to be paid, such as a whole life insurance policy, the value of the gift is the policy's fair market value, which is its replacement cost if the policy owner gifts a single-premium or paid-up life insurance policy or annuity, the value of the gift equals the replacement cost of the contract, which is the single premium that an insurance company would charge for a comparable contract issued at the insured's/annuitant's attained age with term life insurance policies, the gift amount is the value of the unused premium if a new policy was bought for another person the gift is the gross premium paid by the donor

Living benefits

if the insured withdraws the savings value of the insurance and if this value exceeds the insured's adjusted basis—premiums paid less dividends received—the excess is subject to federal income tax in the year of the withdrawal

Taxation of long-term care insurance

in general benefits are excluded from taxable income benefits paid by per diem-based policies are tax-free up to $340 per day-- amounts above this amount can be excluded from income if expenses are equal or greater than this amount insurance premiums and out-of-pocket spending for LTC services qualify as medical expense deductions and are 100% deductible up to the age limit self-employed individuals who are sole proprietors can deduct LTC insurance premiums up to 100% of the premium employer contributions to an employee's LTC premium are excluded from taxable income of the employee

Estate tax

in many cases the life insurance policy owner is also the insured when the insured owner dies, the death benefit amount is included in his gross estate if his gross estate is less than the exempt amount of $5,450,000 in 2016 there will be no federal estate tax due death benefit proceeds are not subject to estate tax if the surviving spouse is the named beneficiary—unlimited estate tax marital deduction is available which fully offsets the taxable death amount if owner names his estate or others as the beneficiary, death benefit amount is included in his gross estate and subject to taxes

Taxation of medical insurance benefits

in the case of employer-provided medical insurance benefits, employers can deduct medical and health insurance premiums and premiums are deductible to employees as medical expenses subject to 10% of AGI benefits to employees are not included in their gross income highly compensated employees must report any medical reimbursements they receive in their gross income if these same reimbursements are not made available to other employees

Incidents of ownership

include any economic benefit in a life insurance policy right to borrow against the policy right to assign or transfer the policy right to receive cash values and dividends right to change the beneficiaries **retaining any incidents of ownership in a policy causes the death benefit to be included in the insured's estate

Gift tax exclusion

law permits the donor to make a gift without tax by excluding the first $14,000 of outright gifts in any 1 specific year to any 1 specific individual $14,000 annual exclusion applies to gifts made to each recipient, irrespective of the number of people who receive from the same donor in the same calendar year

Generation-skipping transfer tax

levied when a property interest is transferred to persons who are 2 or more generations younger than the transferor GST exemption is $5,450,000 for 2016 GST tax is intended to ensure that transfer taxes paid by wealthy persons who might otherwise avoid a generation of transfer taxes by passing their property to heirs beyond those of the next generation value of transferred property in excess of the exemption is subject to the maximum prevailing transfer tax rate of 40%

Gift of insurance proceeds

life insurance death proceeds are not gifts may be a taxable gift if one person owns a policy, a second is the insured, and a third is the beneficiary gift of endowment insurance proceeds likewise occurs when upon the maturity of an endowment policy, the proceeds are paid to a revocable beneficiary of the policy who is not the owner

Premium payments for individual purchased life insurance

not deductible from a person's federal income tax

Applicable credit

or unified credit a tax credit that can be applied to offset estate and gift taxes practical effect of the unified credit is to eliminate transfer taxes on total lifetime and testamentary transfers

Marital deduction

permits tax-free transfers between spouses deduction is available without limit for most types of property transferred to spouses, as long as the spouse making the gift does not retain any control over the gifted property when an ILIT is created with the spouse as beneficiary, a marital deduction cannot be taken to offset the gift tax value of the policy transferred into the trust

Irrevocable life insurance trust

policyowner who is the insured may transfer the policy to an irrevocable trust to keep the death proceeds out of his estate owner must outlive that transfer for 3 years or the death benefit amount will be brought back into his gross estate for estate tax purposes

Taxation of disability income benefits

premiums paid by an employer for disability income insurance for employees are generally tax deductible by the employer and are not taxable income to the employee employee contributions are not tax deductible by the employee payments of benefits under an insured plan or a non-insured salary continuation plan result in taxable income to the employee, to the extent that benefits received are attributable to employer contributions under a non-contributory plan, benefits attributable to employee contributions are received free of federal income taxation benefits attributable to employer contributions are included in gross income and employees are eligible for a tax credit tax credit for the elderly and disabled is available to persons who are totally and permanently disabled

Present interest

situation in which the recipient must have possession or enjoyment of the property immediately annual exclusion is only available when the gift is one of present interest life insurance policies that are gifted to individuals are gifts of a present interest, since the new owner can keep the policy, sell it, or gift it to someone else

Transfer for value

sometimes a life insurance policy is sold for a valuable consideration—may cause the death benefit to be taxed in certain situations under the transfer for value rule the death benefit amount that exceeds the new policy owner-beneficiary's adjusted basis is subject to income tax at ordinary income rates when the insured dies exceptions to transfer for value rule which will not cause the death benefit to be subject to income taxes at the insured's death occurs when the policy is transferred to the following individuals/entities: insured insured's partner transferor's spouse incident to a divorce new owner who takes the transferor's basis in the contract partnership in which the insured is a partner corporation in which the insured is a shareholder or officer

Death proceeds

unless the transfer for value rules apply, life insurance proceeds are exempt from federal income tax death proceeds include the policy face amount and any additional insurance amounts paid by reason of the insured's death if beneficiary takes a series of payments that includes interest earnings in excess of the death benefit amount, federal income tax is applied to the portion of each payment death benefit proceeds are not subject to estate tax if the surviving spouse is the named beneficiary—unlimited estate tax marital deduction is available which fully offsets the taxable death amount

Modified endowment contract

use 7-pay test created by Congress to discourage using life insurance with high premiums as an investment test compares the premiums paid for the policy during the 1st 7 years with 7 annual net level premiums for a seven-pay policy basically people were contributing excess premiums to build up the cash value quickly and then using it as a source of tax-free loans people who decide to use their life insurance as a place to accumulate and then withdraw funds risk having it treated as a MEC and incurring negative income tax ramifications-- FIFO/LIFO and 10% penalty on any taxable gains withdrawn before age 59 1/2 death benefit will remain income tax-free to the beneficiary

Gift splitting privilege

when a married individual makes a gift to someone other than a spouse, it is regarded as made by one-half by each spouse taxpayer in such a situation is given the advantage of doubling the annual exclusion

Gift of premiums

when an individual makes the premium payments on a life insurance policy or annuity contract that he or she does not own, the individual has made a taxable gift to the owner in an amount equal to the premium paid—subject to the $14,000 annual exclusion premiums paid by an insured are gifts if the insured has no incidents of ownership in the policy and proceeds of the policy are payable to a beneficiary other than his or her estate premiums paid by a beneficiary on a policy that he or she owns are not gifts